On average, Swanson Company retains 70% of its earnings and its long-run earnings growth is expected to be 10%. If the risk-free rate, rRF, is 8%, the market risk premium, RPM, is 4%, Swanson's beta is 2.0, and the most recent dividend, D0, was $1.50, what is the most likely market price and P/E ratio (P0/E1) for Swanson's stock today?

Question

Business

Rachael Pratt

2 February, 18:46

On average, Swanson Company retains 70% of its earnings and its long-run earnings growth is expected to be 10%. If the risk-free rate, rRF, is 8%, the market risk premium, RPM, is 4%, Swanson's beta is 2.0, and the most recent dividend, D0, was $1.50, what is the most likely market price and P/E ratio (P0/E1) for Swanson's stock today?

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Victor Monroe · Answer 1

27.5

Explanation:

Fristly, we need to calculate cost of equity using capital asset pricing model:

Cost of equity = Risk-free rate + Beta x Market risk premium

= 8% + 2 x 4% = 16%

Next, we apply dividend discount model to value the stock of Swanson Company:

Stock intrinsic value = Next year dividend / (Cost of equity - Long term growth)

= 1.5 x (1 + 10%) / (16% - 10%)

= 27.5